Download IFC`s Poverty Focus - International Finance Corporation

Poverty Literature Review Brief
(Access to Finance – Financial Infrastructure)
Background
As the largest global development institution focused exclusively on the private sector, IFC’s
mission is to create opportunities for people to escape poverty and improve their lives. IFC does
this through financing the growth of sustainable private enterprises and providing advice to
companies and governments that will enhance the quality and flow of private sector investment
in a country. IFC’s business model is to help catalyze, accelerate and deepen the development
process through private sector development by offering several financial products and advisory
services.
While some of these products and services might directly target the poor, others are broader in
their approach and help fight poverty indirectly. To better understand these transmission links to
poverty, each of the investment industry groups and advisory business lines have conducted a
comprehensive literature review for some select products and services and tried to identify these
links and better articulate IFC’s role in poverty reduction. This paper summarizes the findings
for Financial Infrastructure (Credit Reporting and Secured Transactions).
IFC’s Poverty Focus
As part of IFC’s Poverty Action Plan that was proposed as a response to IEG’s report on IFC’s
Poverty Focus, a short brief was written to better establish IFC’s poverty focus in context to our
operations. This view, endorsed by senior management, states that IFC’s operations can be
considered to focus on poverty if they are (a) reaching people below $8/day PPP and/or (b)
providing people with access to basic socio-economic services and/or (c) providing income
generation opportunities by removing barriers to engaging in the production process. This
poverty focus is aligned with the inclusive business model that targets the poor at the base of
pyramid as consumers or producers.
Hence in drawing the transmission links to poverty, this paper will work with this defined IFC’s
poverty focus.
Product Characteristics
What is the nature of the product/service?
IFC’s Financial Infrastructure promotes financial stability and access to finance through the
development of sound credit systems. Credit reporting is an essential piece of financial
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infrastructure1 that addresses a fundamental problem of credit markets: that of asymmetric
information between borrowers and lenders (Stiglitz and Weiss, 1981), which may lead to
adverse selection, credit rationing, and moral hazard problems. Credit reporting systems facilitate
lending processes by providing lenders with objective information that enables them to reduce
their portfolio risk, reduce transaction costs and expand their lending portfolios. By doing so,
credit reporting systems, enable lenders to expand access to credit to creditworthy borrowers
including individuals with thin credit files, micro entrepreneurs, and small and medium
enterprises. These benefits notwithstanding, in many developing countries, entities that compile
and distribute credit and personal information to lenders are underdeveloped or nonexistent.
Recognizing this gap in information sharing needs, IFC established the Global Credit Bureau
Program (GCBP) in 2001 to foster the development of private credit bureaus in emerging
markets. In recent years, the Program has gradually expanded its scope beyond private credit
bureaus and is also working with public credit registries (PCRs) and on public-private
partnerships in credit reporting. To reflect these changes, the Program has been renamed as the
Global Credit Reporting Program (GCRP). The GCRP’s support for the development of credit
reporting infrastructure is based on country-specific needs. This would entail one or more of the
following activities:
(a) conducting market assessments/feasibility studies and developing a roadmap for
developing the credit reporting system,
(b) supporting the development of the legal and regulatory framework (drafting /
contributing to drafting of laws and regulations),
(c) building capacity for local stakeholders through extensive outreach and awareness,
in-depth advice and training,
(d) supporting stakeholders in procuring the right technical partner, and providing
unbiased support during the project implementation phase,
(e) establishing baselines and indicators for monitoring impact of projects and training
clients on monitoring the impact going forward, and
(f) promoting the development of financial literacy aimed at increasing stakeholder
knowledge of the benefits of maintaining a good credit history.
Since its inception in 2001, IFC has emerged as an international leader in the development of
credit reporting systems, providing support in over 60 emerging-market countries worldwide.
The program has supported the set-up or significant improvement of credit reporting systems in
over 20 countries (Bangladesh, Bosnia, Bulgaria, Cambodia, Cape Verde, Costa Rica, China,
Egypt, Guatemala, Honduras, India, Jamaica, Lao PDR, Maldives, Morocco, Nicaragua, Nigeria,
Panama, Pakistan, Papua New Guinea, Samoa, South Africa, Tanzania, Tonga, Vanuatu, and
Vietnam). In 2010, GCRP has helped generate 31 million inquiries worth an estimated $6.2
billion in new financing to about 6 million retail and small business clients. In coordination with
the World Bank's Doing Business team, the program monitors the credit reporting environment
in over 180 countries worldwide. The program has also provided key contributions to developing
the first-ever universal standards on credit reporting (General Principles of Credit Reporting).
The World Bank, “Financial Infrastructure: Building Access Through Transparent and Stable Financial
Systems”, Financial Infrastructure Policy and Research Series, Washington D.C., 2009.
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2
Effective Secured Transactions Laws and Collateral Registries are another crucial component
of a healthy financial sector and business climate. In their absence, entrepreneurs are unable to
leverage current assets into capital for investment. Firm-level surveys conducted by the World
Bank in developing countries show that unavailability of collateral is not the barrier to obtain
credit: rather, it is the inability to use certain assets to secure credit. A common trend among the
firms is that credit applications are rejected mostly due to insufficient collateral, i.e. unacceptable
or unsuitable collateral. In many cases, business owners did not even bother applying for loans,
because they were certain that they could not meet the collateral requirements often requested by
banks.2
Collateral facilitates credit by reducing the potential loss lenders face from loan defaults. While
land and buildings are widely accepted as collateral for loans the use of movable collateral (such
as inventory, accounts receivable, livestock, crops, equipment, and machinery) is restricted by
nonexistent or outdated secured transactions laws and registries. Reforming the movable
collateral framework thus enables businesses to leverage the greatest part of their assets and
obtain credit for growth. Movable collateral strengthens financial systems by:
Diversification of assets held by financial institutions efficiently spreading the risk;
Reducing concentration in the financial system, by providing banks with profitable
lending opportunities in the SME sector to increase their financial market share
(c) Improved liquidity of assets, especially short-term assets such as accounts receivables;
(d) Increased competition for financial services by enabling non-banks to offer secured
loans;
(e) Improved ability of regulators to analyze portfolio risks in line with both standardized
approaches and internal risk rating models.
(a)
(b)
IFC’s Secured Lending Program promotes and facilitates the development of efficient secured
transactions systems and collateral registries to expand access to finance throughout the globe
with special focus on increasing SME financing. To achieve this objective, our advisory projects
are built on three structural pillars:
Legal Framework: Advice to governments, legal and policy makers and financial sector
players on the necessary improvements to the legal and regulatory environment for
secured lending.
(b) Registry: Provision of technical advice to the government and other stakeholders on the
creation of new collateral registries or the improvement of the existing ones.
(c) Capacity Building: Training and awareness-building among public stakeholders on
compliance with new laws and regulations. Awareness-building among creditors on the
use of the new system and training of creditors on movable asset based lending products.
(a)
Today, IFC is providing secured transactions advice to 23 client countries (China, Vietnam, Lao
PDR, Cambodia, Philippines, India, Nepal, Sri Lanka, Rwanda, OHADA member countries,
Ghana, Malawi, South Sudan, Yemen, West Bank and Gaza, Jordan, Afghanistan, Belarus,
Moldova, Azerbaijan, Tajikistan, Uzbekistan and Colombia). Meanwhile, due to a spike in
2
See “Reforming Collateral Laws to Expand Access to Finance” Fleisig, Safavian, De La Pena, 2006.
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demand for advisory services, there are projects in the pipeline that include work in Haiti,
Liberia, Uganda, Zambia, Sierra Leone, Lebanon, Egypt and Mongolia.
Given the active role and direct experience in the area of financial infrastructure, IFC is
recognized as a thought leader among development finance institutions on this topic. Through its
global reach and strong technical team, IFC has been able to establish a center of excellence on
credit reporting and secured lending with global expertise that leverages regional delivery
models. IFC's status as an international development organization allows it to effectively cut
across diverse and at times conflicting layers and interests and set a level playing field. The long
implementation cycle also requires a long- term commitment to the client needs, which IFC is
able to provide.
Literature review
Financial Development and Growth. Well functioning financial markets contribute to
sustainable growth and economic development, because they typically provide an efficient
mechanism for evaluating risk and return to investment, and then managing and allocating risk.
Singh and Huang (2011) in examining the relationship between financial development and
poverty suggest that financial deepening can positively affect poverty levels and narrow down
the income inequality. They add that interest rate and lending liberalization alone could,
however, be detrimental to the poor if not accompanied by institutional reforms, in particular
stronger property rights and wider access to creditor information. Levine (1997) identifies the
connection between the legal and regulatory environment with financial development and the
overall bonding to long-term economic growth. Li, Squire, and Zou (1998) find a negative
relationship between finance and the level of income inequality as measured by the Gini
coefficient, a finding confirmed by Clarke, Xu, and Zhou (2011), using both cross-sectional and
panel regressions and instrumental variable methods.
In some countries, far more than the bottom 20 percent are poor when measured against the
international standard poverty lines of $1 or $2 a day; in other countries almost nobody is poor
by these demanding standards. To look more directly at the impact of financial development on
absolute poverty, Beck, Demirgüç-Kunt, and Levine (2007) also estimate the change in the share
of each country’s population below the international poverty line that results from financial
deepening. Again, they find a robust effect of finance on poverty alleviation—countries with
higher levels of financial development experienced faster reductions in the share of population
living on less than $1 a day over the 1980s and 1990s.3 A host of other research (Demirgüç-Kunt
and Maksimovic 1998; Rajan and Zingales 1998; Beck, Levine, and Loayza 2000; for a review
of the evidence see Levine 2005) links financial deepening to growth.4
Financial infrastructure (FI) comprising both secured transactions and credit reporting systems
are a core part of all financial systems. The quality of financial infrastructure determines the
efficiency of intermediation, the ability of lenders to evaluate risk and of consumers to obtain
3
4
http://siteresources.worldbank.org/INTFINFORALL/Resources/4099583-1194373512632/FFA_ch03.pdf, p107
Access to Financial Services. Stijn Classens
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credit, insurance and other financial products at competitive terms.5 Strengthening financial
infrastructure promotes financial development and growth.
A. Direct Transmission Links to Poverty
Through removing barriers to income generation for the poor.
Credit reporting and households:
Credit reporting enables households to access credit (retail or consumer credit) by developing
reputational collateral. The effect of access to credit on households has been studied to some
degree. While some research indicates that there are welfare effects of access to credit, others
argue that the poor need a host of financial services (not just credit) such as savings and
insurance to help with consumption smoothing and to counter negative income and health shocks
(Beck, 2008).6
Credit reporting and small firms: Credit reporting systems enable small firms to get more
access to credit to use for growing /expanding their businesses. Beck et al. (2008) review
evidence that links increased access to financial services to growth of small and micro
enterprises and how improving the performance of the finance sector helps firms reduce their
financing constraints.7 Berger and Udell (2005) discuss conceptual issues surrounding
difficulties faced by small firms while obtaining financing, which includes the absence of credit
information, difficulty in registering and recovering collateral amongst other things. Beck,
Demirgüç-Kunt, and Martinez Peria (2005) find that firms in countries with higher levels of
financial system development and greater outreach report lower financing obstacles, with the
association stronger in less economically industrial countries.
Empirical research shows that credit information sharing is critical to lower the financing
constraints for small firms, as it mitigates the effects of information asymmetries in the market.
A study by Love and Mylenko (2004)8 shows that the percent of firms reporting financing
constraints declined from 49% in countries without credit information sharing systems to 27% in
those countries that did have such systems. The same study showed that the probability of a
small firm obtaining a bank loan increased from 28% in countries without credit bureaus to 40%
in those that did have credit bureaus. A well functioning credit reporting infrastructure helps
SME lenders assess SMEs’ risk and creditworthiness profile, make informed credit granting
decisions, and monitor and manage portfolio risk. In addition, credit bureaus act as a disciplining
mechanism for SME borrowers since these borrowers are less inclined to default if they are
aware that this default will affect their future applications for credit.
Link to poverty reduction: Firm growth is linked to growth in employment opportunities. Using
data from 76 countries, Ayyagari, Beck and Kunt (2007) find that in countries with efficient
5
World Bank. 2009.
Beck 2008, 21 (http://www.tilburguniversity.edu/webwijs/files/center/beck/publications/access/wbro.pdf)
7 http://www.tilburguniversity.edu/webwijs/files/center/beck/publications/access/wbro.pdf, 12
8 Love, I. and Nataliya Mylenko, (2004), “Credit reporting and financing constraints”, The World Bank, Policy
Research Working Paper Series: 3142.
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credit information sharing, the employment share of SMEs in manufacturing sectors is larger.
Klapper, Sarria-Allende and Zaidi (2006) find that young micro and small medium enterprise
firms in Poland are active employment generators. However, they face financing constraints,
some of which can be alleviated through the use of credit registry information.9
Credit reporting and microfinance: The impact of microfinance on poverty alleviation is
discussed in various papers. Some research has looked at the impact of credit reporting for
microfinance and has found that the establishment of credit reporting systems offers expanded
credit opportunities for microfinance borrowers (de Janvry et al. (2006), McIntosh and Wydick
2009). Further McIntosh et al. (2009) find that that improved screening effects from the credit
reporting system caused the level of portfolio arrears of the MFI lender to decline approximately
two percentage points after it was implemented in branch offices. They observe an even more
substantial and significant effect of the information system in reducing late payments that occur
during the loan cycle.
Secured Transactions and Collateral Registries: Without an effective movable collateral
system, lending is riskier and financial institutions respond by either lending less or increasing
the cost of credit to cover their risk, especially to asset-deficient borrowers such as small firms
and low-income households. Economic analysis also suggests that small and medium-sized
businesses in countries that have stronger secured transactions laws and registries have greater
access to credit, better ratings of financial system stability, lower rates of non-performing loans
(Djankov, McLiesh and Shleifer, 2005), and a lower cost of credit (Chaves, de la Pena, Fleisig,
2004).
In emerging market countries, for lack of appropriate secured lending regulations and collateral
registries, the assets owned by most firms are a poor match for the assets that lenders accept as
collateral. According to the World Bank Enterprise Surveys, in these countries, nearly 80% of
firms’ assets are inventory, machinery and accounts receivable, while 78% of the assets taken by
financial institutions as collateral are real estate (land or buildings). This collateral gap can be
significantly reduced by strengthening movable collateral regimes. In addition, Dahan et al
(2008) find that implementing a form of secured lending can attract foreign investment due to
legal certainty. At the same time, Beck et al (2008), using data from a survey to banks in 45
countries10, shows the importance of the use of collateral to avoid obstacles for SMEs to obtain
credit.
Although there are different institutions that acknowledge the importance of Secured
Transactions and the existing literature links the use of such system to improve the financial
markets conditions for SMEs and its impact to reduce poverty, no empirical research has been
conducted to measure the impact that Secured Transactions Systems have on a firm or individual
level.
9
Leora F. Klapper, Virginia Sarria-Allende and Rida Zaidi. A Firm-Level Analysis of Small and Medium Size
Enterprise Financing in Poland. World Bank Policy Research Working Paper 3984, August 2006
10Bank Financing for SMEs around the World Drivers, Obstacles, Business Models, and Lending Practices.
Thorsten Beck, Asli Demirgüç-Kunt and María Soledad Martínez Pería. World Bank, 2008.
6
B. Indirect Transmission Links to Poverty
Research shows that credit reporting and secured transactions systems reforms are linked to
overall increase in private sector lending. While this is not specific to the poor or the base of the
pyramid, we infer from links to other research that financial development is linked to economic
development.
Overall growth in credit: Djankov et al. (2007) find that better creditor rights and the presence
of credit registries are associated with a higher ratio of private credit to GDP. Additionally
private credit to GDP ratios rise following improvements in creditor rights or the introduction of
credit registries (Djankov et al. 2007). Love and Mylenko (2003) and Jappelli and Pagano (2001)
also find that higher lending is associated with the presence of credit registries (specifically
private credit registries). Turner and Varghese (2007) show statistically significant increases in
private sector lending (as a share of GDP), associated with increased rates of coverage by private
bureaus. A change from no coverage to 100 percent full-file coverage is associated with private
sector lending rising between 48 percent and 60 percent of GDP, depending on the exclusion of
outlier observations. Jappelli and Pagano (2001) find that the sharing of credit information is
associated with higher lending, as measured by the ratio of private credit to gross national
product and lower defaults. Barron and Staten (2001) also show that greater availability of
information reduces default rates and improves access to credit.
In countries where security interests are perfected and there is a predictable priority system for
creditors in cases of loan default, credit to the private sector as a percentage of gross domestic
product (GDP) averages 60 percent compared with only 30 to 32 percent on average for
countries without these creditor protections.11 Therefore, modern secured transactions systems
increase the level of credit.
Through the IFC Secured Lending Program over US$ 3.5 trillion have been facilitated to
enterprises in China since 2007, of which US$ 1.1 trillion have been extended to SMEs. In
Ghana, the Law to pledge collateral has been reformed and a collateral registry has been
established. This registry is mostly used by individuals and SMEs, accounting for over 85% of
the charges received during 2011. It has also made possible to leverage over $2 billion while the
increase of women borrowers has been steady, accumulating 47% of the total charges made in
the second semester of 201112.
Improving financial market performance and supporting financial development by reducing
non-performing loan rate: Credit bureaus and registries allow lenders to evaluate risks more
accurately and improve the quality of their portfolios. A study conducted by the Inter-American
Development Bank,13 measured the impact of information sharing on loan performance. The
IADB examined data from a 170 banks in Bolivia, Brazil, Chile, Colombia, Costa Rica, El
Safavian, Mehnaz, Heywood Fleisig and Jevgenijs Steinbuks, 2006. “Unlocking Dead Capital: How Reforming
Collateral Laws Improves Access to Finance.” Private Sector Development Viewpoint, No. 307, World Bank,
March 2006.
12 Bank of Ghana Collateral Registry Operational Report, 2011.
13IADB, IPES 2005: Unlocking Credit: The Quest for Deep and Stable Bank Lending. (Washington, DC: IADB,
2004) p. 178. http://www.iadb.org/res/ipes/2005/index.cfm. p.178
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Salvador, and Peru in order to measure the impact of private and public bureaus on loan
performance. It found that banks which loaned primarily to consumers and small businesses and
used private bureau data had non-performance rates that were 7.75 percentage points lower than
ones which did not.14 Jappelli and Pagano (2000) looked at 43 countries in their study including
most OECD countries, and estimated that sharing of positive credit information reduced credit
risk by between one third and one half.
Reducing transaction costs: In a survey of banks in 34 countries conducted in 2001 and 2002,
more than 50 percent of the respondent banks said that information sharing reduced loan
processing time, costs, and default rates by 25 percent or more (World Bank 2004). Chaves et al
(2004) and more recently Lago et al (2007) analyze the use of collateral to secure a loan and they
show that by using this system, firms get lower interest rates, thus reducing the cost of credit.
Strengthening property rights: The law and finance literature has stressed the importance of
legal institutions (especially those protecting private property rights) in explaining international
differences in financial development. Where legal systems enforce private property rights,
support private contracts, and protect the legal rights of investors, lenders tend to be more willing
to finance firms —in other words, stronger creditor rights tend to promote financial development
(Acemoglu and Johnson, 2005, Cottarelli et al., 2003, Dehesa et al., 2007, McDonald and
Schumacher, 2007, Tressel and Detragiache, 2008, and Singh et al., 2009). De Soto (2003)
argues that the developing world has accumulated a great deal of wealth, but without legal
institutions that establish and defend ownership and property rights, much of it is “dead capital”
that cannot be sold or collateralized to back loans. The lack of such a legal framework makes it
particularly difficult for the poor to leverage their informal ownership into capital.
Increasing transparency: Credit registries systems improve transparency, rewarding good
borrowers and increasing the cost of default, and could reduce the reliance of the poor on
informal finance. Detragiache et al. (2005), Djankov et al. (2005), McDonald and Schumacher
(2007), and Singh et al. (2009) all show that information-sharing is associated with greater
financial development.
C. Impact on the Base of Pyramid ($8) and the Absolute Poor ($1.25)
From our literature review, there is no current research out there that definitively links credit
reporting and secured transactions to the impact on those at the lowest bottom of the pyramid
(either $1.25 per day or $8 per day). However, recent research on the use of alternative data for
credit reporting (i.e. data from non-traditional sectors like utilities, telecommunications, etc.)
show that certain segments of the population that are traditionally underserved financially stand
to gain access to credit. In “Give Credit Where Credit is Due” Turner et. al. (2007) find that 21%
more credit applicants earning $20,000 or less annually in the United States see their credit
applications be accepted and 15% more applicants amongst those earning between $20,000 and
14
Turner et. al. 2010.
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$29,999.15 These income groups would be considered as being below the poverty threshold
according to national poverty line definitions.
D. Making the Case for IFC Operations
Over the past five years, IFC’s Global Credit Reporting Program has been collecting data
from bureaus that it helped set up or improve. Initially the Program focused on collecting inquiry
data as a proxy for the number of loans generated as a result of consultations with the bureau. In
2010, the Program started collecting information on the number of loans generated as a result of
consultations with the bureaus and the number of new loans (to new borrowers, as a proxy for
increasing access to credit). Based on information collected from four bureaus in Central
America (where IFC held an investment that was subsequently divested in 2007), new loans in
2009 as a percent of the total number of loans generated by users of these bureaus ranged
between 10% to 18%. Unfortunately there is no benchmark data against which to compare either
initial lending volumes or new lending volumes. The Program has stopped collecting data from
these bureaus (as the project ended well over five years ago). But it will strive to collect this data
from other more recently set up operational bureaus, including in Nigeria, Morocco and Egypt.
IFC’s Secured Lending Program has equally gathered information measuring the volume of
credit granted to companies through Collateral Registries. Baseline data is being collected yet
due to the length of the implementation of these reforms, only the results of the earliest reforms
are available, such is the case of the projects in China, Ghana and Vietnam.
E. Conclusion
Financial infrastructure is critical to financial market development, which promotes economic
development and growth. While a plethora of research exists out there that draws the links
between financial infrastructure and financial market development, not much has been done to
explicitly look at the links between financial infrastructure development and poverty alleviation.
More research is needed, expanding the existing data and focusing on the direct and measurable
impact that sound financial markets have in alleviating poverty. Following are some areas of
research that could focus on specific variables:
 Credit Reporting: Impact on the access for households, income and consumption
smoothing, micro, small and medium enterprises. .
 Secured Transactions and Collateral Registries: Impact on the business growth and job
creation associated with MSMEs.
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15
Turner et al. 2007.
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